Lowe’s Companies, Inc. (NYSE:LOW) has paid a dividend each quarter since going public in 1961. Even more impressive, the company has raised its dividend for 53 consecutive years – a feat achieved by fewer than 15 companies.
Not surprisingly, LOW has a handful of competitive advantages that have enabled it to enjoy meaningful growth. While the stock is not currently in our Top 20 Dividend Stocks portfolio, it’s one that long-term dividend growth investors should keep on their radar.
At the end of September, 56 funds from our database amassed some $3.35 billion worth of Lowe’s shares, unchanged over the quarter. Value investor Edgar Wachenheim of Greenhaven Associates is a big fan of Lowe’s Companies, holding 9.84 million shares, which represented more than 13% of Greenhaven’s 13F portfolio at the end of September.
Let’s take a closer look at the business.
Business Overview
Lowe’s Companies, Inc. (NYSE:LOW) was founded in 1946 and is the world’s second largest home improvement retailer. The company operates over 1,800 home improvement and hardware stores (almost all in the U.S.) and helps homeowners, renters, and professional customers complete a wide array of projects from do-it-yourself to do-it-for-me.
A typical LOW’s store stocks about 36,000 items across virtually every home improvement product category (e.g. lumber, paint, appliances, flooring, tools, cabinets, etc.). Less than 5% of LOW’s sales are made online today, but the company’s strategy is focused on omni-channels sales to capitalize more on the e-commerce trend.
Business Analysis
Home Depot (HD) and LOW dominate the U.S. home improvement market. Each of these companies benefits from strong brand recognition, prominent store locations, a comprehensive line of products and services, economies of scale, and a strong focus on customer service.
Smaller competitors are unable to match the broad assortment of inventory and in-store product presentations that LOW and HD can afford. They also have much less bargaining power with suppliers, making their products less price-competitive. Consumers have few reasons not to head to HD or LOW for their home improvement needs.
LOW has also been improving its competitive positioning by investing more in technology and product presentation. Through the use of technology and helpful in-store displays and service, customers have even fewer reasons to try out competitors’ stores.
Finally, the home improvement market is very large (LOW estimates the U.S. home improvement market was valued at $690 billion in 2014) and slow-changing. Mature industries dominated by several large players are very difficult to crack into, and we believe LOW will continue its dominance for many years to come.
Key Risks
With any brick-and-mortar retailer these days, it’s important to consider the risk (if any) posed by lower-cost e-commerce competitors such as Amazon.com, Inc. (NASDAQ:AMZN). In LOW’s case, we view this risk as low because many of its products are for unique home projects.
Physically going into the store to review paint colors, cabinets, flooring options, and more is critical to getting the project right. We don’t believe that many of LOW’s product categories are vulnerable to online competition and note that LOW’s is investing significantly in its own e-commerce capabilities to further ward off this threat.
Most importantly, LOW’s is sensitive to the housing market. When the job market is weak, consumer spending is down, housing prices have fallen, mortgage rates are high, and housing turnover is low, there is less demand for home maintenance, repair, and upgrade projects. The housing market has been recovering for a number of years now, but the time to buy LOW’s would have been during the depths of the housing crisis.
Aside from macro factors related to the housing market, no major risks jump out at us. The home improvement retail industry is slow-changing, and LOW’s benefits from economies of scale, strong brand recognition, quality merchandise selection, and decent store locations. It’s hard to see the company being disrupted for many years to come.
Dividend Analysis
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. LOW’s long-term dividend and fundamental data charts can all be seen by clicking here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
LOW’s dividend Safety Score of 83 suggests that its dividend is safer than 83% of all other dividend stocks in the market.
Follow Lowes Companies Inc (NYSE:LOW)
Follow Lowes Companies Inc (NYSE:LOW)
Over the last four quarters, LOW’s earnings payout ratio is just 32%, which provides plenty of safety and room for dividend growth. Longer-term, LOW’s EPS payout ratio has increased from less than 10% in 2007 to around 30% last year (see below). This means that LOW’s dividend growth over that time period outpaced its earnings growth.
Eventually dividend growth will moderate to match earnings growth, but a payout ratio of 30% still leaves plenty of room for outsized dividend growth over the near-term.
Source: Simply Safe Dividends
Source: Simply Safe Dividends
LOW’s business held up surprisingly well during the housing crisis. The company’s sales were down only slightly in fiscal year 2009 and fiscal year 2010, although diluted earnings per share dropped by about 20%. While we believe the company is sensitive to the economy, perhaps its repair business helps buffer its results a bit during rockier times.
Source: Simply Safe Dividends
We can see that LOW’s return on invested capital declined from fiscal year 2007 through fiscal year 2010 as the housing market softened but has started climbing up since then. The company’s returns have been pretty consistent, which indicates that LOW’s might have a moat.
Source: Simply Safe Dividends
Importantly, LOW’s has been an excellent free cash flow generator. As seen below, free cash flow per share has grown nicely over the last decade, and we would expect additional growth as LOW improves the efficiency of its stores and eventually slows growth capex.
Free cash flow generation is very important because it allows a company to comfortably reinvest and return capital to shareholders without the assistance of capital markets.
Source: Simply Safe Dividends
Turning to the balance sheet, LOW’s most recent debt to equity ratio was 1.5. This is a bit higher than we like to see, but the consistency of LOW’s cash generation and the slow pace of change in the home improvement retail industry alleviate most of our concerns.
The company’s net debt / EBIT ratio is also strong at 2.1x. This means that LOW’s could eliminate its debt with cash on hand and just 2.1 years of EBIT.
To conclude, LOW’s dividend payment is very safe and appears well positioned for many years of growth ahead.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
LOW scored a very strong dividend Growth Score of 96, suggesting that its dividend has some of the highest growth potential that investors can find. The company’s low payout ratio, reasonable balance sheet, and strong cash flow generation support its score.
LOW has increased its dividend for more than 50 consecutive years and most recently raised its dividend by 22% earlier this year. The stock is one of 51 dividend aristocrats and has grown its dividend by nearly 20% per year over the last five years. We expect double-digit dividend growth to continue over at least the next 3-5 years.
Source: Simply Safe Dividends
Valuation
Lowe’s Companies, Inc. (NYSE:LOW) trades at 23x forward earnings and offers a dividend yield of 1.5%, which is slightly below its five year average dividend yield of 1.6%. LOW’s dividend yield is too low for investors living off dividends in retirement, but its long-term dividend growth potential is very strong.
From a total return perspective, we believe LOW could generate 8-12% annual earnings growth over the next five years. When combined with the stock’s current dividend yield, LOW’s stock could return 10-14% per year.
However, we think LOW’s earnings multiple already bakes in a decent amount of earnings growth and would prefer to buy the stock at an earnings multiple no higher than 20x.
While we see fundamental factors that could continue driving LOW higher over the next few years (e.g. aging homes, more baby boomers investing in their properties), it’s hard for us to get too excited about the stock at today’s price.
Conclusion
LOW’s is a high quality home improvement retailer with numerous competitive advantages. The company is benefiting from a mix of company-specific actions to improve profitability and macro tailwinds that are helping the housing market.
We believe the company’s dividend growth potential is very attractive given LOW’s conservative payout ratios, decent earnings growth potential, and reasonable balance sheet, but it’s hard to justify the stock’s current multiple. The stock is worth keeping on the watch list, but we prefer other blue chip dividend stocks at this time.
Disclosure: None
